Explained: Why are foreign investors no longer funding Indian startups? 

Whilst COVID-19 emerged to spell doom for the global economy back in 2019, it induced a golden period for the Indian startup ecosystem. Indian companies suddenly became the favourites of global investors as they kept pouring in massive funding incessantly. It’s evident from the fact that Indian startups raised $13.2 billion in funding in 2019 and $10.9 billion in 2020. Then, 2021 turned out to be a ‘year of unicorns’ for the Indian economy, which saw Indian startups raising a record $35.2 billion in funding and producing at least 34 unicorn startups. 

However, the golden period seems to have come to a grinding halt now. Just two years down the line, the Indian startup ecosystem is facing a grave funding crisis. To put things in perspective, Indian companies have raised a mere $2 billion in the first quarter of 2023. This amount is 75 per cent lower than the same period last year, as per Reuters. 

Private equity and venture capital funding have also seen a drop of 60 per cent during the Q4 of FY23. At this miserable run rate, Indian companies might end this year with just $10 billion in funding, far less than $35.2 billion in 2021 and $20 billion in 2022. Experts say the Indian economy won’t see a repeat of the 2021-like funding boom in the coming decade. 

Reasons behind the funding crisis

Both global as well domestic factors have triggered the dry funding spell for Indian companies. High interest rates, inflation, the banking crisis and the global economic slowdown have left global investors anxious. It must be noted that Indian startups have raised the majority of their capital from foreign investors only, so global factors directly impact the funding climate in India. 

Central banks around the world have resorted to increasing interest rates to tackle inflation; however, this has ratcheted up the borrowing cost. Adding to that, the banking crisis in the US has further tightened liquidity. The imminent recession in Western countries has further exacerbated the woes of global investors. It’s speculated that the US economy, along with Germany and UK, will enter recession in FY24. 

Domestic factors that have led to the funding crunch

On the other hand, there are also some domestic factors to blame. Of all, the biggest factor is the faltering consumption growth in India. As per a report by Indian VC firm Blume Ventures, the consumption growth in India is driven by a “tiny superuser set.” Consumption outside the top layer of 30 million households has actually dropped sharply. As a result of this, the target market for Indian startups has reduced to a mere 100 million people, below 10 per cent of India’s total population of 1.4 billion.

Moreover, global investors are fast realising the fact that many Indian startups which they funded earlier were massively overvalued. For instance, Blackrock cut the valuation of Indian EdTech company Byju’s by half from $22 billion to $11.15 billion. Similarly, Swiggy’s valuation was also slashed by a quarter by Invesco. Investors are waiting for further correction in the valuations of Indian companies. For example, Softbank has steered clear of Indian companies during the last year after leading the funding boom in earlier years.

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According to SME futures, the slowdown in funding activity can also be attributed to the changed norms for foreign direct investment (FDI) introduced by the government of India in 2020. This has led to confusion among several foreign investors, making it even more difficult for Indian fund-seekers to raise capital from international VC firms. 

Rachit Poddar, Co-Founder of IVY Growth Associates, was quoted by SEM Futures as saying, “One of the main challenges that Indian start-ups face when seeking foreign investment is a lack of understanding of the Indian market by foreign investors. Additionally, regulatory hurdles and the complexity of the Indian tax system can be deterrents for foreign investors.”

Indian government must do more

Although the Indian government has launched several programmes to shore up the Indian startup ecosystem, such as the Start-up India Programme and the Fund of Funds for Start-ups; experts believe that might not be enough. There is still much to be done to make regulations simpler, lower administrative barriers, and encourage investors to fund early-stage start-ups. The government needs to work towards promoting private investment in startups.

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Despite all odds, it remains a fact that the Indian economy continues to be a bright spot in a world fast slipping into economic turmoil. As per projections made by IMF, India and China will contribute half of the global growth in FY24. India remains the world’s fastest-growing major economy, which is expected to grow at 6.8 per cent in the ongoing fiscal year. As relations between China and the West continue to deteriorate due to geopolitical tensions, India will clearly emerge as the only promising investment destination for international VC firms.